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February 13, 2012

At Volcker Rule Deadline, a Strong Pushback From Wall St.

Wall Street made its broadest assault yet against new regulation on Monday, taking aim at a rule that has come to define the battle over how to police banks in the aftermath of the financial crisis.

Regulators in charge of writing the Volcker Rule, which would ban banks from trading with their own money, were inundated with complaints and suggestions on Monday, the deadline to comment on a draft proposal. More than 200 letters were expected to be filed by the midnight deadline on the rule, which regulators outlined in October.

Commenters included the rule’s namesake, Paul A. Volcker, the former Federal Reserve chairman, who submitted a strongly worded defense of the rule’s intent in a letter on Monday. Others, like consumer advocates and lawmakers, criticized the draft rule for not being tough enough.

Senators Carl Levin of Michigan and Jeff Merkley of Oregon, both Democrats, led the effort to insert the Volcker Rule in the Dodd-Frank act, the sweeping regulatory overhaul passed in response to the financial crisis. In a comment letter on Monday, the senators said the proposed rule was “too tepid.”

But the loudest response came from critics like Wall Street trade groups and banks, who want to soften the rule. The rule, the critics said, is a threat to the health of the financial industry and the broader economy.

“This will make the overall economy less stable and less conducive to growth,” David Hirschmann, head of the Center for Capital Markets Competitiveness at the Chamber of Commerce, said in a letter.

The pushback against the Volcker Rule is the latest effort under way on Wall Street to mute the impact of Dodd-Frank. But the campaign against the Volcker Rule is more pronounced than banks’ earlier attempts to temper new regulations for lending and derivatives.

Wall Street firms, lawyers and trade groups churned out many Volcker Rule appeals. The Securities Industry and Financial Markets Association, or Sifma, hired the law firm Davis Polk to write multiple pitches to regulators. A hodgepodge of Wall Street trade groups led by Sifma alone filed five comment letters on Monday, including one document that spanned 173 pages. A regulatory comment letter normally runs 10 to 20 pages. During the writing period, most big banks formed internal Volcker Rule “task forces,” often led by risk officers and lawyers, to coordinate the effort across trading desks and divisions, people briefed on the efforts said.

The letter writing went right down to the deadline. Over the weekend, a dozen or so lawyers huddled on the 17 floor of Davis Polk’s Midtown Manhattan headquarters, making final changes to more than 10 letters written on behalf of banks and Sifma.

“I’ve never seen a rule-making response like this before,” said Derek M. Bush, a partner at the law firm Cleary Gottlieb who helped write comment letters for banks and financial industry groups.

Wall Street’s biggest banks even submitted their own comment letters, taking an unusually aggressive stance that underscored the importance of the issue. Ordinarily, banks prefer to have trade groups and lobbyists do the talking for them.

But with profits — and the future model of the industry — at stake, Goldman Sachs, Morgan Stanley and Citigroup each submitted a comment letter, people briefed on the matter said. The letters were not yet public, but they were expected to be filed before the midnight deadline.

“Firms usually feel that it’s best to work only with the trade group letter,” said Margaret E. Tahyar, a partner at Davis Polk who worked on several Volcker Rule comment letters. “But the Volcker Rule is such a major shift, that many, many firms felt they needed to also write letters in their own name.”

Banks have held meetings with regulators to spell out their case. Goldman officials have met six times with the Securities and Exchange Commission over the last three months.

The insurance industry also injected itself into the debate, arguing that regulators need not apply the Volcker Rule to their business, according to people briefed on the matter.

The scope of the Wall Street pushback reflects the complexity of the rule. The draft rule that regulators unveiled last October spans about 300 pages and poses some 1,300 questions for the public to address.

Now, the comment deadline ushers in a critical phase. Equipped with arguments from every side, regulators will turn their focus to completing details of the rule.

Still, it could take months for the five regulators — the Federal Reserve, the S.E.C., the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission and the Office of the Comptroller of the Currency — to sift through the hundreds of comment letters. Financial industry lawyers have already forecast that regulators will miss the July deadline to put the rule into effect.

Wall Street, sensing opportunity in a delay, urged regulators to take their time. Some letters suggested that the regulators “repropose” the rule, or scrap the earlier proposal altogether and start from scratch.

Supporters of the Volcker Rule say that is a ploy to delay it until after the 2012 election, which may end the Democratic control of the Senate and the White House.

“It’s part of their ongoing strategy — if you can’t kill the rule, you may as well delay it as long as possible,” said Dennis Kelleher, president of Better Markets, a nonprofit group that advocates stricter financial regulation.

The Volcker Rule aims to ban banks from placing bets with their own money, a practice known as proprietary trading. The rule is based on the belief that banks that enjoy government backing — like deposit insurance — should not be able to trade in this way.

Much of the debate over the Volcker Rule will center on defining what amounts to proprietary trading. The line can be blurred between proprietary trading and legitimate market-making, a practice in which banks hold securities with the intent of selling them to a customer. Regulators have acknowledged that deciphering that gray area is difficult.

The chief critics of the Volcker Rule have seized on the imprecision, saying that securities markets rely on banks holding large inventories of bonds so that investors can buy and sell them easily. The rule’s attempts to distinguish between trading and market-making “would have significant deleterious real-world effects on financial markets and on the investors and customers that rely on such markets for liquidity,” Sifma wrote in its comment letter.

But holding large amounts of securities has hurt banks. During the financial crisis, banks suffered huge losses on assets that were originally intended for clients, like the mortgage securities that meant big losses for Citigroup and Merrill Lynch. And banks’ inventories of financial assets ballooned in the years leading up to the financial crisis, leaving them particularly vulnerable to losses when customer demand for the assets dried up.

The rule’s supporters argue that banks are defining market making so broadly that it could include some forms of risky proprietary trading. “Holding substantial securities in a trading book for an extended period obviously assumes the character of a proprietary position, particularly if not specifically hedged,” Mr. Volcker wrote in his comment letter.

Or, as Mr. Kelleher put it, “Calling something market making doesn’t make it so.”

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